View From the Top

Opinions expressed whether in general or in both on the performance of individual investments and in a wider economic context represent the views of the contributor at the time of preparation.

View from the very top: in an historic event that will have profound ramifications politically, economically and for financial markets, the UK has voted to exit from the European Union. Inevitably there will be (at least temporary) negative consequences for risky assets and this will likely prompt a flight to safety, even if buying opportunities do occur over time. We have counselled for some time growing allocations to truly uncorrelated asset classes, and our conviction in this respect has only grown.

The decision for the UK to seek to end its 43-year membership of the European Union should not be considered a black swan event since the scenario had been discussed for many months. While the world will clearly not come to an end, regardless of one’s political standpoint, it has undoubtedly become more risky. Moreover, the negative consequences of this decision will clearly extend beyond the UK.

The British Government is not legally bound to accept the result of the referendum since it is technically just a consultative process. Nonetheless, the decision of David Cameron to stand-down suggests that it will abide by the result. Under any scenario, however, the genie is out of the bottle. A clear disconnect has arisen between a frustrated population and the political establishment, where fears over migration have trumped the economic uncertainties of exiting. The repercussions will be widespread across the rest of the continent, with the EU now facing a fundamental identity crisis. Other member countries will likely follow suit in seeking referenda, elevating overall risk levels.

The question, therefore, is not whether risk assets fall, but by how much, and to what extent Central Banks react. A few things at least, seem clear. First, the risk of a recession in the UK and also the broader EU has risen. The UK had outperformed almost all other western economies in terms of GDP per capita growth since joining the EEC in 1973. Now, it will likely be poorer, more isolated and somewhat at the mercy of its larger European neighbour over whose affairs it is forsaking influence. Next, greater uncertainties will keep Central Banks positioned towards an easing bias. Indeed, the market is now discounting that the Fed will not raise interest rates for the next two years. Meanwhile, the Bank of England will also likely look to cut rates at its next meeting. Finally, volatility levels will likely remain elevated, especially given the many unanswered questions that have arisen as a consequence of this decision.

In terms of how to position, given that we are now entering an era of elevated risk, the logic for investing in genuinely uncorrelated asset classes continues to strengthen. We have advocated for some time the case for catastrophic reinsurance, infrastructure assets, direct lending and private equity. Equities, in broad terms, will likely come under pressure, with fixed income and gold correspondingly benefiting. Such a seismic Brexit decision will, however, also create opportunities over time. For now, we would prefer to be prudent, since the summer will likely bring further uncertainties.

Alexander Gunz, Fund Manager, Heptagon Capital